Suppose That People Finally Realize That They Must Save a Larger

Essay

Suppose that people finally realize that they must save a larger proportion of their income in order to retire and that they simultaneously begin to use new technology that allows them to reduce their holdings of real cash balances as a proportion of their income. Use the IS-LM model to illustrate graphically the impact of these two changes in household behaviour on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.